This is a revised proposal to study the structure and function of the hippocampal formation in psychosis. Hippocampal volume deficits are among the most robust brain abnormalities in chronic patients with schizophrenia. More recent studies have now established that hippocampal volume reduction is already present in the early stages of psychosis - in patients who develop schizophrenia as well as those who develop bipolar disorder. It is unclear, however, whether hippocampal pathology can explain the psychotic features or the well-known memory deficits in schizophrenia and bipolar disorder. Here the applicant is proposing to test the hypothesis that hippocampal dysfunction is necessary (but not sufficient) for the production of psychosis. Memory deficits are predicted to be prominent in schizophrenia and bipolar disorder because cortico-hippocampal interactions are perturbed in psychosis. To test this hypothesis, two groups of patients will be studied with novel morphometric and functional imaging approaches. First, two forms of hippocampal-dependent memory (i.e., the ability to remember episodes and the ability to infer relationships among items) will be studied in chronic patients with schizophrenia. This will allow the applicant to test the prediction that hippocampal dysfunction in conjunction with cortical and thalamic abnormalities can explain specific memory deficits in schizophrenia. Second, schizophrenic and bipolar patients will be studied at the time of their first hospitalization. Hippocampal function during episodic and relational memory task performance is predicted to be abnormal in the early stages of psychosis, whereas cortical dysfunction is less prominent compared to chronic patients with schizophrenia. The proposed studies are designed to elucidate the crucial role of hippocampal dysfunction for the production of psychosis and the development of cognitive deficits in schizophrenia and bipolar disorder.